[00:02:40] Yonah works for Madison SPECS, one of the biggest cost segregation firms in the country.
[00:03:06] Yonah had recently surpassed 1000 posts on BiggerPockets.com
[00:03:34] You can schedule a free consultation with Yonah at http://bit.ly/Yonah15Min – You should do this if you have ever wonder whether cost segregation is right for you!
[00:07:30] Yonah believes that you have to learn from those who have done it before you.
[00:09:47] If you are not doing cost segregation, you are doing straight-line depreciation.
[00:09:56] The IRS allows you to write off the entire value of a building. For commercial, it’s over 39 years period and for residential it’s over 27.5 years.
[00:10:18] The main categories of cost seg:
- Actual Structural Components of the building
- Personal properties depreciate over a 5 year period (include fixtures, lighting fixtures, special purpose plumbing, etc.)
- Land improvements (depreciate over 15 years): Landscaping to pavements, to asphalt a parking lot etc.
[00:15:34] Yonah used real number examples to demonstrate bonus depreciation and cost segregation for mobile home parks.
[00:19:53] Yonah discusses whether you could use the benefit of cost seg to offset your W2 income.
[00:20:50] Yonah discusses briefly about real estate professionals and using it to offset the entire W2 income.
[00:24:48] I asked Yonah about Cost segregation and Airbnb for a friend. If you have an Airbnb business, you will want to listen to this section.
[00:35:05] Yonah shares the questions you need to ask a firm before hiring them to do your cost segregation study.
Yonah Weiss 0:02
These successful and success is really, you know, relative kind of term. But I would say, and you probably heard this before, because I’ve said it before this and all the podcasts that a person who is truly a happy person, successful or rich person is someone who’s happy with what they have. So, being rich is not about monetary wealth. It’s about you know, being truly satisfied, being truly happy with with what you have and you know, not kind of looking to see, you know how I can always be making more but being totally content with where you’re at.
Unknown Speaker 0:39
Welcome to the show, you are listening to the real estate lab podcast. In this lab. we decode the stories, secrets and skills of the most brilliant minds in real estate investing and turn their wisdom into practical advice and knowledge that we can use to boost our income. And now let’s turn it over to our host Vee.
Hey, is a great day to To be alive and to invest in real estate, my name is Vee Khuu. And you’re now listening to my show the real estate lab podcast. Let me ask you this. Are you interested in keeping more money for yourself? Do you know about the tax loopholes that the mainstream media keep on telling us that is only available for the rich?
You know, the loopholes that someone in a high office used to not pay any taxes at all. Our guest is here today to show you how you can benefit Also, if you are an overworked doctor, you can participate in this. If you are a spouse of a dentist who happened to runs your Airbnb rental on the side, you can participate in this. It worked even for the rest of us worker bees that are trapped in the rat race.
You will wonder why your CPA never discussed about this tax deduction with you after listening to our show today. This guest and I, we discuss about a tools called cost segregation and how you can use it To save millions of dollars from our least favorite Uncle, uncle sam. So who is our guest today? He is a blockchain enthusiast. He is a Super people connector is guys know pretty much everyone you need to know in the real estate industry.
He is super super busy yet he volunteer for a nonprofit and helped raise over $100,000 for needy widows, orphans and underprivileged families. He’s also a licensed Realtor with the Israeli Ministry of Justice. Now, that’s just one small part of this guest impressive resume. So who is this person?
As a business director at a national cost segregation leader Madison SPECS, he helped numerous of investors save on their taxes every year. Over the last 14 years, Madison SPECs have done over 15,000 studies covering all 50 states and what Result? over $3 billion in tax saving. That’s super impressive.
Ladies and gentlemen, our guest today is Mr. Yonah Weiss. Yonah is on a mission to get to 1000 posts on bigger pockets. So if you’re a member on bigger pockets, and you see any posts that he can add value to make sure make sure to tag him.
Also be on the lookout for his new podcast called Weiss advice. Make sure you check out Yonah profile on LinkedIn and bigger pockets as well.
If you’re interested for a free consultation with Yonah check the show notes for the link. Real quick if you have not leave a review at five star rating or subscribe to the real estate lab podcast, do me a huge favor, head on over to iTunes after the show to do it. It would help me out tremendously.
Last but not least, make sure you join our free Facebook community as well. I want to give a huge shout out to our admin Rajesh Tekchandani and Vinney Chopra, one of our expert guests. They have recently closed on a 200 unit apartment in Orlando, Florida. I am sure you can learn a tons from them. Just head on over to www.EastWestVentures.co/AIMS to join. Alright, let’s dive into my conversation with Yonah Weiss from Madison specs.
Welcome to another episode of the roost a lab podcast. It is my honor to have Yonah Weiss here. Yonah, Shalom, how are you doing?
Yonah Weiss 4:44
Shalom, I am doing well Vee. Thank you so much for having me on the show. It’s a pleasure to be with you.
Awesome. I I saw your schedule this morning on LinkedIn is a crazy schedule. So I really appreciate you jumping on with me here. So let’s just dive right in. I understand You had a background in education for more than two decades doing that, what were you doing in that field?
Yonah Weiss 5:08
Really learning and teaching, I’m like, I’m a lifetime learner. So I love to learn and love to teach. And I have six kids. So as part of my, you know, even from when I was when I was young, a teenager, I was, you know, a camp counselor and doing some, you know, high school tutoring and so it’s kind of been in my blood just to kind of, you know, something, you can help others and, you know, teach them and share with share your knowledge.
So then At what point did you say you want to get involved in real estate?
Yonah Weiss 5:36
Oh, you know, I guess it was about five years ago, when, you know, I just needed some, some things happen in my life or really changing, you know, some environments, and I was just looking for opportunities, and I wasn’t really looking for real estate, to be honest, but I thought about it. What is a field that I would like to get into I didn’t want to go into any more formal schooling. I’ve been in formal schooling postgraduate you know, for a long time, so I didn’t want to go back to school to learn something new.
Yonah Weiss 6:08
At the same time, I thought what would be a field that I could you know, pick up by just mentoring, apprenticing with other people and kind of learning on the go, and what could potentially have the most lucrative outcome. And real estate just kind of naturally made sense. And I had a lot of people that I knew were in the field already. So I just reached out to a few people and a couple opportunities came my way and just kind of jumped in.
Awesome. So what did you do at the beginning?
Yonah Weiss 6:37
So the beginning I started out with a friend of mine who his uncle owned a small boutique commercial real estate financing firm, so we were doing a mortgage brokering. I was just learning from everything about commercial real estate at that point and brokering loans and hard money loans and you don’t have sort of sourcing financing underwriting. You name it.
So in a in a few short years, you said four or five years ago in a few short years, how did you go from someone who is new in the field to now Your name is synonymous with cost segregation?
Yonah Weiss 7:13
I think it has to do like I said before connecting with and really apprenticing the real experts, because you’re not going to learn things on your own, you’re not going to become great on your own. Just, you know, being a self made like like, like that even exists.
Yonah Weiss 7:30
There’s no such thing as self made, you really have to learn from those who have done it before you and that’s kind of where I got involved with Madison specs, the company I currently work for, they’re literally the experts in the field, you have people who’ve been in industry for for decades, and doing everything in the commercial real estate field. So just you know, learning side by side from them.
So the topic that we will be discussing today is obviously cost segregation, which is an area that you are an expert In. Let’s just take a basic step here. I understand cost segregation is more or less, you take a building and you break out each component of that building and you depreciate it over time, according to the IRS code. Can you just kind of walk us through? Who does what and how does that work? At what point do we go to Madison spec, yourself? Or what point do we go to a CPA? Just just the whole thing, how the whole thing put together?
Yonah Weiss 8:30
It’s a really interesting idea that cost segregation allows you to accelerate depreciation like you mentioned that. But CPAs don’t necessarily do this because it’s something engineers needs to do. It’s something a firm that needs to that specialize in this needs to actually take part in preparing that according to the IRS rules, which is why accountants really don’t specialize this albeit there are many, there are many firms, accounting firms that will do this in house. So they’ll have engineers in house that do this. But those are usually the large accounting firms the big four, you know, large carriers really accountable to do this. What we do is, like you mentioned, break down the property into those small, you know, those assets, instead of taking the tax write off every single year, a small amount over, you know, 39 years over 27 years, you can actually take a larger amount in the first five years by front loading a certain portion of that.
Can you talk more about the front loading component and how each asset has a certain lifespan right so you how do you categorize what goes to what and how does bonus appreciation and depreciation plays into all this?
Yonah Weiss 9:47
So yeah, so the, the main categories, you know, if you’re not doing cost segregation, you’re taking what’s called straight line depreciation.
Yonah Weiss 9:56
Can you buy a building the IRS allows you to write off the entire value of That building over for commercial a 39 year period or for residential multifamily over 27 and a half year period. The front loading and the reallocating of assets comes into play when the engineer the cost segregation engineer comes in. And really, there’s two, three main categories.
Yonah Weiss 10:18
One main category is the actual structural components of the building. And that’s what most people just take everything. And if they’re doing straight line depreciation, they just throw everything into that bucket and take a small deduction each year, but that’s really not accurate even according to the tax code. You’re supposed to be separating it out and really doing cost segregation according to the actual right way of depreciating your property.
Yonah Weiss 10:44
This other two categories are what’s called personal property which depreciate over a five year period and that can include anything from furniture to appliances. You know fixtures, lighting fixtures, you have special purpose plumbing, if you have cabinetry countertops, things like that in a building, even carpeting or floor tiling will actually fall under that five year category, which means you can depreciate the entire value of all of those things in the first five years. Now, the second category is land improvements which depreciate on a 15 year schedule. Okay, so now we have three categories we have, you know, the main structural components of the building and think of that, like the structure and that’s the main component that’s usually going to consist of the majority of the value of the property. Then you have the other two components which are the, the personal property are the tangible movable property which isn’t necessarily always movable. But IRS considers it to be so and that appreciates on a five year schedule. Third category is the 15 year property, the land improvements and that can include anything from landscaping to pavements curving asphalt to a parking lot, have a driveway, you have a sidewalk on your property, right even, you know a path all the That all the landscaping depreciates on a 15 year schedule.
Yonah Weiss 12:04
Now, you mentioned bonus depreciation, how does that work? It’s actually not something separate from cost segregation. It’s the same thing. It’s just allows you the IRS came up with a new rule that allows you to take instead of separating out those three categories, the five year, 15 year and the 27 and a half year, you can actually know take the entire five and 15 year property meaning any the depreciation less than 20 years and you’re allowed to take that entire amount in your number one, which that’s what 100% bonus depreciation so that’s probably the biggest thing that’s happened to the real estate tax world in probably the last 2030 years.
Okay, so I just want to clarify something when you mentioned earlier the commercial building the depreciation is over 39 years?
Yonah Weiss 12:55
Okay. So that count as apartments or commercial buildings for retails and` strip malls and whatnot.
Yonah Weiss 13:02
So apartments fall into the residential category. So even if they are, you know, a 300 unit multifamily apartment complex that IRS still considers them residential, even though it’s you know, theoretically a commercial property, but for tax purposes its residential. Commercial would include anything else. So whether it be office, retail, industrial, you know, self storage, and anything in between.
Okay. A follow up to that is regarding the land improvement. I understand that cost segregation doesn’t really work in mobile home parks. But in your example that you said early, you have a 15 years period for land improvement does that work in that scenario also?
Yonah Weiss 13:41
Absolutely. In fact, mobile home parks can actually be one of the best I guess the word I’m looking for his. Someone who could take the most advantage I can think of a word right now.
Yonah Weiss 13:55
I’ve been going since way early this morning,
the most advantageous?
Yonah Weiss 14:01
So I’m a little bit giddy right now. Yeah, mobile parks can actually get probably the most tax deductions from cost segregation than any other type of asset out there. And and that’s because in many cases, mobile home parks are entire, especially when they’re entirely tenant own homes. So the tenants actually the homes, you as the landowner just own the land, right.
Yonah Weiss 14:28
But you own the land improvements, which includes the pavements, right, the pads under each home, and all the landscaping the roads in between those. So basically, what you own is the land, which land itself doesn’t depreciate. So there’s a certain amount to every property that you have to separate for land land allocation, which does not depreciate and then you have land improvements. There are some structural components there in the home parks like sewage, and you know, main structural piping and electric stuff like that, but the majority of that is going to be land improvements and you’re looking at literally, sometimes mobile home parks where they’re all completely tenant on homes can be 60 70% of the entire value is that 15 year land improvement.
Yonah Weiss 15:14
Now, when you’re talking about bonus depreciation, that means you can take that entire tax deduction in the first year. Okay, so let me use a real numbers, right? What does that mean? Let’s say you buy a property for a million dollars, a mobile home park, and let’s say right, let’s say after land, oh, you bought it for $1,200,00 and you separate $200,000 for land.
Yonah Weiss 15:34
Okay, well, they have a million dollar property. Okay. 70%, let’s say potentially can be that land improvements. That means you can have a $700,000 tax deduction in the first year for buying a million dollar property. Right, and you have to actually spend $700,000 worth of oil, nothing. Okay. No, think about it. If you buy a million dollar property, and your Financing it once you’re putting down 200 $250,000 Okay, now you get a $700,000 tax deduction. So you can spend $200,000 and this is women one and get a 700,000. And it’s crazy, but that’s exactly how it happens. And I have people with long parts reaching out to me left and right, because this is something that is just blowing people’s minds. And and it’s really true. Now, not every moment will have that, you know, 70% that is a extreme example, because a lot of times there’s some, you know, parkwood homes as well and so that will contribute to the more of the structural components etc. But it’s usually at least 50% because what we’re talking mobile home parks, so that’s huge golf courses. Another one actually that that fits into that category, but multifamily properties usually is more like you’re at a 20% 20 to 30% allocation, which is still great, which means you can buy a million dollar property, get it to $300,000 tax write off, which again, is incredible! It almost doesn’t make sense. But, but, but it’s true.
Well, yeah, it’s true. And you know, depreciation is one of those things does the IRS force you to to take regardless, you know, you when you sell a building, you have to pay for recapture regardless. So I don’t see why not just going in and you know, take the depreciation and accelerate it.
Yonah Weiss 17:23
Exactly, yeah, taking much advantage as you can now take that cash flow, especially if you need those tax deductions. Take it now and use it.
So in, let’s say, in the scenario of a syndication and I’m the GP, I don’t need the depreciation. How is it possible that I can pass it over to some of the limited partners that need that tax write off? Let’s say the limited partner is a doctor or a dentist that you know has a lot of income, how does that work and also talk about the bonus depreciation who qualify for that? Are there certain asset or certain investor profile that the need to qualify?
Yonah Weiss 18:08
No the bonus depreciation you don’t need any qualification in that and I’ll get to the first question second. But the bonus depreciation is really a choice. You can choose to take that hundred percent bonus depreciation and you can take to choose to front load that entire amount in the first year. You can also just choose to do the regular cost segregation which accelerates it and still gives you a larger tax deduction over the first five years, but it doesn’t get you that whole big huge chunk in the first year.
Yonah Weiss 18:35
Now, back to your first question, which is about the limited partners versus the general partners who’s getting the tax deductions unfortunately, high net worth individuals who are you know very high networth high you know, W2 jobs at doctors lawyers, they may be getting passive, wanting passive income from the investments they’re doing as a limited partner. However, they may not be able to take advantage of the tax deductions beyond They’re actual income from the properties.
Yonah Weiss 19:03
What I mean is, if you have an income from the property, whatever income is coming from the property, the depreciation can now be used to offset that income. Okay, what we’re doing is you have, let’s say $100,000 income, hundred thousand dollars of tax deductions, it’s wiped out you have zero tax liability, you pay zero income tax on the property.
On the property?
Yonah Weiss 19:25
On the property correct. However, if the doctor has a $400,000 $500,000 income from his job, he’s not going to be able to use the tax depreciation to offset that income. It’s only going to be sheltering the income from the property.
Okay, so how does someone like that? Because I’ve heard a lot of people who said I can pass this deduction through to the limited partners, so correct me or how does it work for them?
Yonah Weiss 19:53
So how it works is like this. There’s really two things number one is that yes, the deductions get passed on Those partners but they may not be able to use them, okay? It also means they’ll be able to use it to offset entire amount of their income, okay, which is great, which means whatever income they’re getting is going to be tax free, at least in this first five years. That’s usually the case those passive incomes, however, it may just it may stop there, okay? And they’re not going to be able to shelter their tax or their taxable income from other from their w two job. However, there are really two other things that I said there’s two things but there’s three. The first thing was that right. The second one is really is to the so the first one is that whatever income the limited partners get from the property, they can use the tax deductions from the depreciation to offset that meaning they don’t have to pay taxes on that income.
Yonah Weiss 20:50
However, the other thing is that if they have other passive investments, okay, let’s say they have other passive income, whether it be from other properties they own Or whether it be from other -` maybe soon as another business interest passive income, then depreciation can also be used to offset that income as well meaning it doesn’t have any limit to property because the depreciation kind of cross pollinate to other properties as well or other passive income. Okay, so that’s one one advantage that other investors could have. The other thing is and really, this is the ticker and this doesn’t actually apply to the limited partners or the passive investors but really applies to anyone and everyone is that if you can get the real estate professional status, okay, which is a box that you check your tax returns, which shows that you are materially involved in real estate investing, have ownership and are materially involved invest in actually managing or operating or you know, be involved in renovations of any kind of broken properties. You can actually use depreciation to offset all of your income not just from the front or from any other source.
Yonah Weiss 22:02
But it gets better. It doesn’t necessarily have to be you, it can be your spouse, okay? And this is really where the tickets are the kicker, whatever you want to call it, this is where the Big Bang is you’re getting, let’s say you have your you’re a doctor and your spouse is a real estate agent, right or is involved in property management, or involved in in running some properties. You now qualify as a joint, jointly finding taxes as a tax as a real estate professional. Now you can use contribution you can use those depreciation deductions to offset all your income from any source and your spouse’s.
Okay, and this is fairly easy to get qualify right? I think is around 16 to 18 hours of real estate activity a week to get your qualify?
Yonah Weiss 22:51
Yeah, it’s it’s 750 hours a year. It’s not particularly easy, but I mean in the fact that it is possible Okay, which means that it’s not it needs to be tracked as ours even track. But yeah, anyone can do it, anyone can do it, you don’t need to any qualification, you just need to actually have the hours more than 50% of your time has to be involved in real estate. So if you have a W two job, it’s probably not possible or feasible to also spend equally or more hours in real estate and materially involved. However, if you have a spouse, that’s really the way to go.
Okay, so So just to recap, in order to take advantage of this, you need to be a real estate professional, or doesn’t really matter, it cannot offset your active income.
Yonah Weiss 23:37
Correct. And it is, it’s, it’s the best way to take advantage of this. It’s not the only way but it’s definitely the best way.
Okay, and so let’s just take a step back and say so cost segregation doesn’t work for, let’s say, a single family homes where someone bought it for as an Airbnb investment.
Yonah Weiss 23:56
Yes, it can be for Airbnb investment, it can be for any Any type of property. My general rule of thumb is that if a property is purchased for over a million dollars, there’s usually it’s almost a no brainer that there’s going to be tax benefit there is going to be worthwhile. When the property is smaller than that maybe under a half a million dollars it usually doesn’t even make sense. It just there’s not enough meat on the bone again, we’re talking about unless the mobile home park because again there we can have, you know, there’s so much meat on the bone. But if it’s not, you know, you’re talking about a 20% maybe reallocation there’s just not a lot there when we’re talking about the actual tax deductions. So So yeah, any property can do can do it doesn’t have to be multifamily doesn’t have to be commercial could be even a single family house. If it’s if the purchase price is high enough Can you can make it worthwhile.
Right as I’m asking this because I’m thinking of a friends who just recently bought a single family homes in Southern California for Airbnb, so In that situation I understand you can break up the component different components inside a house and write it off depends on the schedule that the IRS has out there. What about the stuff that she bought for her business? Let’s say beds and everything else that goes along with that business?
Yonah Weiss 25:15
all that goes in there because if you think about it, all of that stuff is part of the personal property. All part of that and fits into that five year category. Right? It’s part of you know, is if you think of as a business, but it’s really you know, it’s an investment property and all of that, you know, movable property goes along with it.
So all that chattels go along with that right then just five years, you can write everything off the year, first year?
Yonah Weiss 25:39
So she already let’s say, past last years, and now we’re going into the second year of owning this property, can she go back in retrospect and do it?
Yonah Weiss 25:51
Yeah, retroactively. You can go back you can get the tax deductions retroactive which is incredible, because there’s almost there’s almost no reason not to To get like, like what we do will provide like a feasibility analysis, which will show you what you know the tax benefits would be if you’re just doing straight line a lot of people they don’t know about cost segregation, and they’re just doing straight line depreciation and they’re taking that little amount every year.
Yonah Weiss 26:14
There are many people who don’t even know what depreciation and their their accountants really doing a huge disservice. And not even giving them the tax write offs that they so rightfully deserve. But I’m not talking about that I’m talking about just people taking break the straight line depreciation. If you did that, and you’ve owned a property for a year or 2, 3, 5 years, you can actually go back retroactively and get those missed accelerated tax deductions in the first year. And it’s like bonus depreciation because you’re getting what you missed over those past five years. And you’re going to get all that in your one because that stuff depreciates on a five year schedule. So in case your friend who’s just had it for one year, actually, if it’s been within the past year, and they haven’t yet claimed any type of cost segregation
Yonah Weiss 27:01
Then they can actually claim bonus depreciation as well, even retroactively as long as they didn’t opt out of it by by depreciating property separately.
So if they did the straight line depreciation year one now going into year two, they can do a cost seg study and and claim those depreciation.
Yonah Weiss 27:20
Yonah Weiss 27:22
what would some, what would something like that usually costs? And when does it make sense to do it? When does it make sense not to do it.
Yonah Weiss 27:34
Like I said, it’s definitely worthwhile any property over half a million dollars, especially over a million dollars, it’s worthwhile to reach out to a firm like ours to get a quote or an estimate. And in that will show you that analysis of what the difference would be if you’re doing straight line depreciation versus if you’re doing cost segregation. So that’s, that’s no cost whatsoever. We do that as a service for free. Anyone can reach out anytime. Get that and it’s really you You can helps you to make an educated decision to see if it’s worthwhile or not. Because there’s no real black and white, is it worthwhile? Is it not? It really depends on a person’s personal tax situation. And if they need those extra deductions, there is a lot of advantage to doing it. And there are some disadvantages. There are some reasons why person may not need, they may not need those tax deduction, it may just be going to waste and it may so it’s definitely worthwhile to reach out for that. What about the timing?
Yonah Weiss 28:25
Like I said, you can do retroactively you don’t have to do it in the first year ownership you can and a lot of people do because they want to take advantage of those tax deductions right away or pass those to the investors they want to you know, offset other income they may have other gains they may have and they can use the cost segregation in the first year. So definitely worthwhile to try to get a hold of it in the first year. But again, you do not need to and you can actually get it back retroactively.
Okay. Another question just came up.
Yonah Weiss 28:53
Oh the cost also, right, you mentioned the cost, right? I will include in that what the cost would be which is is not based at all on the tax benefits not based on contingent to what you’re getting gonna save for it. Rather, it’s a one time flat fee based on the scope of work and has a lot to do with, you know, the number of units or the square footage and what type of property is. But generally speaking, in most of the cases, I’ve seen a huge massive properties, somewhere between four and $7,000 in that range.
That’s a lot cheaper than what I’ve heard before. I’ve heard somewhere between 13 and 15 grand and what So what you’re saying is, it’s definitely worth a shot to to just try it out and, you know, call your firm or call some other firm, whoever offer the feasibility studies for free basically, exactly.
Yonah Weiss 29:47
Yeah, I mean, get the free analysis, you know, what I mean? Like, check it out, see if it’s worthwhile see if in your situation it would make sense or not. And that’s, that’s, that’s doesn’t cost anything. It’s really quite educational actually.
So earlier I mentioned another question that I just have is, let’s say you’re buying a building, but the owner had already have that building for a long time and already the cost seg did the the bonus depreciation, I’m sure it was different, you know, this new bonus, the appreciation that President Trump just passed, just, you know, still new. So in that situation, let’s say if you are assuming the loan, nothing changed, you’re buying this property, but you’re buying the LLC. You’re not buying the property itself. So no title transfers, you’re just buying the LLC. In that situation. Does it work still for cost seg?
Yonah Weiss 30:42
Because what happens is the IRS considers depreciation starts over when there’s transfer of ownership, as long as it’s a, an arm’s length, non arm’s length, sorry, an arm’s length transaction, meaning if you’re passing it just from one LLC to another, but and you’re just the same person And then there’s no real change of ownership in that case and depreciation does not start over.
Yonah Weiss 31:06
If you’re passing it over to a close blood relative as well. The IRS considers that a non arm’s length transaction and therefore this is also not considered a change of ownership really because it’s really kept in the family However, if you’re you know, just buying a property from someone else even if it’s your that LLC transfer, you are actually buying apartment the IRS considered it and the new purchase price is what is actually being depreciated by you. So even if the previous owner bought the property for a million dollars five years ago, and you’re bought and they’re depreciating it on a five, you know, on that schedule for a million dollars, that’s their defeasible basis. That’s how much tax rate if you buy the property for $10 million. Now your tax write off is $10 million dollars.
Okay, so, same situation, let’s say that the old the seller Still have that building right? Bought it for a million still has $500,000 on the loan, I’m coming in, I’m giving a million dollars to the seller , I’m assuming that half a million. So at that point is my base, one and a half million or a million,
Yonah Weiss 32:15
your basis is whatever the actual transaction price was. So it doesn’t really matter if you’re assuming a loan or not. It matters what the you know, the settlement statement says what’s the closing price that’s in the IRS that establishes the new basis and the new ownership.
Got it? Okay. And the other thing I want to ask you is the regard to the methodology of cost segregation. Because I when I read on the IRS website, just briefly, there’s rule of thumb and then there is actually that the court have no methods to cost seg so when your company, Madison Specs come out and do something like that. Is there a procedure that your company developed? is is it’s different from company to company or it’s pretty much standard all across?
Yonah Weiss 33:03
It’s normally I wouldn’t say standard all across but if you if like you said if you look on the IRS website, if you go and scroll through the cost segregation audit techniques guide, there are really several different methods of doing cost segregation. Right. And the one you mentioned the rule of thumb method, okay, right. I think that the someone who can just kind of guesstimate based on some experience but but very little details can kind of come up with a number of what the depreciation should be without any actual facts without any actual findings. If you read the clearly what it says there it says that, that is not actually don’t know this by heart, but but it says there and you can actually look it up there. It says there that you can, it’s not really recognized and won’t hold up an audit by the IRS. So they actually state it. They said you can do this, but it doesn’t really hold up strongly in an audit. However, there is something called a quality cost segregation study, which is also listed there in what is there’s different approaches of doing cost segregation. And that’s the approach that we, we use Madison specs, and probably the approach that I would assume the majority of you know, large cost segregation firms like ours, are using it as an engineering based approach. And they follow up all the details. And it’s actually if you read that you’ll see there are 13 principles. The IRS delineates that go into a quality cost segregation study, which include You know, there’s a numbering system that they developed, there’s a know a proper nomenclature you have to use, you have to find you have to have pictures, you have to have, of course, a documentation of actually being at the property. There’s the list goes on. So, you know, when you when you’re looking at a quality cost segregation study, which it says explicitly there in the code, that’s what will stand up to an audit. So you want to make sure that you’re following the rules.
So how do I differentiate between a bad cost seg study and a good one?
Yonah Weiss 35:04
I mean, you want to ask is this A quality approaches? is an engineering approach? Is that or you know is what’s the experience? What has you know, something you want to ask the firm? it? What’s your experience in cost segregation? You know, is this something you’ve been doing for a year? Or two or 10? Or how long? How many studies have you done? How many times have you had the clients been audited? If they have never been audited? Have Have you had your have your studies stood up to those audits. And these are questions that I get all the time for clients. So this is something that you need to just be aware of, and make sure that you’re doing it in the right way. Listen, if you have you know, high risk tolerance, there are even some like these, like you said, these rule of thumb type things that people are doing. I actually know some accountants that they’ve never done a real cost segregation study and they just kind of guesstimate, and they keep the numbers pretty low just to be conservative, but they’ll guesstimate say okay, let’s say 4% to land improvements. You know, like and you know just put that in in numbers, they don’t have anything to prove it. They don’t have anything to back it up. They don’t necessarily have you know, square footage and all these they’ll just put in the depreciation 4%. They’ll come with that number and I asked them once, like, when i when i friends is an accountant who does this, this is like, what do you do? If you ever get audited? He’s like, well, like, what? There’s not 4% of the properties land improvements, like yeah, of course, they’re like, it’s just logic, meaning he’s using a logical approach and like, like, show me like, there’s landscaping here. You’re saying that’s not even 4%? So that’s kind of his logic, and he feels comfortable enough with that logical approach, but I wouldn’t necessarily recommend it.
And honestly, on a side note, I want to ask you so in a cost seg study, how do you know how much percentage to put aside to allocate to land that you cannot depreciate?
Yonah Weiss 36:58
That’s a really good question. Actually. And there is real, no definitive way of deciding that. And the truth of the matter is, because that’s so we we usually don’t make that decision, we’ll leave that to our clients or their accountants to kind of figure out what that is. Now, there are some ways the IRS doesn’t because the IRS doesn’t say explicitly how much you have to allocate to land it just has to be some sort of reasonable approach. So some people use, they’ll use an appraisal, now a third party appraisal will come in and do that sometimes they’ll use the county assessor what the property taxes would assess the land allocation to be, but sometimes the county assessor and especially places like California, and other places where the land allocation is going to be very, very high, the land value is going to be really high and a lot of people aren’t comfortable with that, and will try to take another approach to find a lower land allocation. I mean, you’re talking about I know people that you know, California that have 50 to 60% is being allocated to land. So you’re talking about whatever is left over When you purchase price, that’s what you can depreciate after allocating to land it’s ridiculous but so the want to try to cut that down as much as possible.
So then so then back to the mobile home park situation and that whole place is just just land so you running, you cannot run off 100% off of your purchase price.
Yonah Weiss 38:19
Well, like I said before, it’s not really land, it’s also land improvements. And and, and there may be a reason to allocate more to land, but in many cases, you know, mobile home parks are in places where the land value is actually really low. So to say I’m buying a mobile home park for a million dollars, you know, and maybe it’s five acres or whatever, but five acres of land and you know, who knows where Tennessee is not gonna be worth a million dollars is gonna be worth like $10,000 right? So to allocate more than 10% more than 1% in that case to land is not even logical, but you still gonna have to put with something reasonable. So that but it will not be the entire amount. Like I said, the majority in that case is going to be the land improvements will be where the real value is.
Thank you for clarifying that I you know, and that’s that’s the part where I kept on being confused about because to me mobile home park is just like all land, right, but in what you’re saying and you’re still breaking out the part by component, you still going in with land improvement. The land itself is the land itself, you still have to allocate something and then everything else you can depreciate
Yonah Weiss 39:37
That’s actually is a lightbulb moment for me. Alright, so let’s just fast forward to another question that I have. And this is regarding 1031 exchange. So you have property A you do your cost seg study, you do your bonus depreciation, you write off everything and then let’s say 10 years later Now it’s time to sell you do a 1031 exchange, you roll that into property B, right and you do the same thing. And then eventually you go to a property C, D, E and F. Eventually you have to you either die or you pay taxes. So at that point, at that point, how does the depreciation recapture work?
Yonah Weiss 40:22
That’s an interesting question. First of all, just to clarify for people who are listening in depreciation recapture, tax is a tax you have to pay upon sale of a property, okay, you take depreciation it’s great, all you have the property, but when you sell, you have to actually pay a tax on that. To get around that if you do a 1031 exchange, not only as you know, if you don’t know 1031 exhcange allows you to defer the capital gains taxes, maybe the gain that you’re getting on the sale of that property, you buy a property for $10,000 all for a million dollars. You haven’t paid 25% or 15% capital gains tax if you 1031 exchange that You can get around that you can defer that. Okay. You’re also deferring the depreciation recapture tax. So we’re pushing it out or pushing it further down, and you’re rolling it down the road, as they say, and like you said, until you die like this, you know, you swap to the drop, right? Yeah, keep going, keep going as far as you can, at that point, if if a person you know, at that point, they either die or they pay taxes, like you said, but there are a couple ways around it, there’s actually you can, you know, put it in a trust a lot of people do, they’ll put it in the properties in a trust and have that be inherited by the children, which would actually, they would not be at that point with the with the depreciation, neither would the person who owned it. So there is really a way to get around that even even at the end of the road.
But let’s just say you, you want to just cash out and use the money at that point, right. I’m trying to see. I understand the depreciation schedule walk with the 1031 it walked from property to property. So in the end of just say you’ve done this three, four times, you do go back to the beginning and you pay taxes on on that on the first property and then the second property in
Yonah Weiss 42:11
No, I mean, you’re once the property has been fully depreciated, which is really something also interesting once again, fully appreciated. Then there’s no depreciation recapture because there’s no longer any depreciation left. There’s nothing left in the basis.
No, but so, if we if we depreciate it, and that the bonus depreciation and we did the cost seg, we take everything out year one so really we’re taking everything. So there’s nothing left to the depreciate year two, right?
Yonah Weiss 42:46
No, again, we’re not taking everything what we’re doing is we’re taking those assets that are accelerated, so the five year property 15 your property and again, let’s just take our example multifamily, let’s say is 20% Okay, 10 20% of your taking in year number one, your number two, and you know, two through 26, you actually have the rest of 80% of the value of the building that you are Yes, yes depreciating. So just to give you some numbers and an example of what that would look like, let’s say your problem is a million dollars. Again, just keep it around. If you did straight line depreciation, you’d be getting about $30,000 a year as depreciation, right? Now, if you take bonus depreciate and get 20% of that $200,000 up front, in the first year. Now in years number two through 26, you now have instead of the 200,000, you took already, you know 800,000 to depreciate over the rest of the 26 years. So instead of that 30,000 you would have had straightline every year, You took $200,000 and first year and then for two through 26. You’re going to be left with about a 25 $24,000 depreciation so you’re still going to be getting depreciation deductions every year. years. It’s just not going to be as much as it would have been originally.
Got it. Got it. Okay. And then if you did this game long enough, and you don’t have anything left to depreciate, you don’t have to pay for recapture.
Yonah Weiss 44:12
Yeah, pretty much. Okay.
And I and I understand the recapture taxes, cap at 25%
Yonah Weiss 44:19
is a little more complicated than that, but but in most cases for property, yes.
So if let’s just say you are a high net worth individual and you’re paying a lot of taxes, where your tax rate could be in the high 40s. And you can write off a lot of your income by get either getting a real estate professional status or having your spouse getting that status.
Yonah Weiss 44:45
And then when you have to pay this back, you only paying in at 25%. You can arbitrage that.
Yonah Weiss 44:50
Yeah, you could take that route. Yeah, that’s, you know, again, there are many strategies make different strokes for different folks, right, you’re going to have to look at your long term strategy. But you also, you know, maybe looking at not paying income tax for X amount of years, and it’s really, you know, going to keep you in the long run with that cash flow coming in.
That’s, that’s awesome. And is there anything else that I need to ask you that I forgot to ask them? I’m sure. There are many things that because I’ve listened binge listen to a lot of your webinar. And
Yonah Weiss 45:28
I can tell you got all the questions.
It’s just like, you know, I’m missing something in some of those webinars. So that’s why I want to ask, and, yeah, so I’m sure I’m miss a lot. So is there a topic that I need to ask and I forgot?
Yonah Weiss 45:44
I’m sure there is but I really can’t think of anything right now.
Okay, one last question before I let you go then. I know that you you have a lot of quotes and Jewish sayings that you like, what is the most what’s Your favorite success or mindset quote, or Jewish saying
Yonah Weiss 46:04
success, or mindset quote or Jewish saying, I guess I would say that be successful. And success is really you know, relative kind of term but I would say, and you’ve probably heard this before because I’ve said it before, listen to all the podcasts that a person who is truly a happy person successful for a rich person is someone who’s happy with what they have. So being rich is not about monetary wealth it’s about you know, being truly satisfied being truly happy with with what you have and you know, not kind of looking to see you know how I can always be making more but being totally content with with where you’re at.
Awesome. Thank you so much, Yonah. I really appreciate you jumping on to this podcast episode with me today.
Yonah Weiss 46:55
Vee has been truly my pleasure and you got me in a funny moment right now. First day back from two weeks vacation and literally been going nonstop for about like 10-11 hours at this point. So I apologize that a little little giddy and, and and stuff but glad we have this opportunity.
Awesome. Thank you Jonah,
Unknown Speaker 47:16
Love this episode of The Real Estate lab podcast, share the show with your friends, subscribe and give the show a five star rating on iTunes. Until next time, have an awesome work week.